Easy Money and Vanishing Trust

The key message of Stephen King’s book is that “we” have been living beyond our means. In his words: “We became delusional. We convinced ourselves that capital markets could deliver ever rising prosperity. We thought we could borrow without limit, always confident that the future would be better than the past.” And not for one moment, he adds, “did we think we would ever succumb to Japanese-style economic stagnation or Argentine-style broken promises.”

King emphasizes that we are all in the same boat, and that we were all wrong. It is fair to say, however, that some raised a voice of concern. Economists of the Austrian tradition in Spain started to warn about an impending crisis early on. The real-estate bubble was more extended in Spain than in the United States and the ill-effects played out very much the way the Misesian and Hayekian theories would have predicted.

The focus of this book is “The End of Western Affluence.” Its main title notwithstanding, it is not about the exhaustion of paper money. Rather, it is about the dearth of money available for easy redistribution. It joins other books, by authors of various ideological stripes—such as The End of Ethics by Malloch and Mamorsky and Douglas E. Schoen’s The End of Authority —in arguing that world as we know it is about to end and we need major changes. In the same manner that the Great Depression of the 1930s shifted the terms of the economic debate, the recent crisis has led many to rethink their premises.

King devotes several pages to the frightening scenario of an Argentine future for leading Western economies, particularly the United States and United Kingdom, if they do not correct course. Again, money did not run out in Argentina. The recurrent crises there were caused by the increased costs to government of easily locating money to redistribute. When they ran out of people from whom they could steal, their deceptions wore thin and the voters replaced the administration. Unfortunately, Argentina’s electorate has done this through the years with nary a change in the policy decisions at the top.

The seven or so pages that King devotes to Argentina accurately summarize its economic history. Some of the political history could have been covered more thoroughly, though. It would have helped to describe the complicated battle lines within the extreme left and the extreme right of Peronism during the 1970’s.These factions led to the violent period of the dirty war which had little to do with economic or monetary policy.

Also, readers would have profited from a better picture of how the policies of several Argentine governments—especially the manipulation of money and credit, and the interventionism favored by most of them—led to the breakdown of trust. This, after all, is what King highlights as the fundamental problem in the West. When trust breaks down, the mentality is that only those who are close to political power have a better future in store. Growing up in Argentina, in my teens and well into my twenties, I was a convinced cynic harboring the “un-American” certainty that the past was always better.

I was surprised, while reading King’s analysis of the Argentine case, by the monetary policy he recommends to bring about a return to affluence:

If nominal growth is lower than 4 per cent, the central bank should endeavor to push growth higher and not worry too much about whether the reacceleration results in higher activity or, instead, higher inflation.

That is exactly the kind of thinking which contributed to the destruction of the Argentine economy.

King follows his analysis of Argentina with an analysis of Japan and its decades of stagnation. That must have influenced his opinion on monetary policies. But if the goal is to avoid the Argentine destiny, then one should avoid copying Argentine policies. Argentine central banks rarely tried to lower inflation with their policy. The confidence that supposedly is restored with higher growth “even if the increase resulted more from higher inflation than from a higher volume of activity” is short-lived.

In the same manner that he strikes me as too lenient and optimistic about paper money, he is too critical of “Nineteenth-century monetary regimes,” which he claims “proved to be a source not of financial calm but, instead, of continuous economic and political upheaval. The monetary rules at the time may have been simple and part of the conventional wisdom of the day but they proved unsuited to a world that was undergoing rapid change.”

Monetary policy can’t avoid all political and financial follies. The author acknowledges that, despite deflation, “living standards in the developed world mostly rose in the last three decades of the nineteenth century” but repeats misconceptions about world gold shortages being a constraint on growth. If he comes up with a second edition, King would profit from reading the contributions of George Selgin and Larry H. White on the monetary history of that century.

Knight twice quotes Milton Friedman and Anna Schwartz on “how important what people think about money can sometimes be.” Austrian economists have underlined this point. They have propounded a subjective theory of value—that economic value is not an intrinsic characteristic of a good—and extended the analysis to money. In short, paper money today is accepted by the majority of the people who care little that is has no backing at all. The prudent performance of some central banks—take the case of Argentina’s neighbor, Chile—reinforces the trust that people have in paper money.

In addition to its description of what happened when “the money ran out” in Argentina and Japan, the book also covers how Indonesia, Malaysia, and Korea confronted their economic crises. Issues of political leadership played an important role in all three. In South Korea, stronger cultural cohesion and a lower level of government spending made the adjustment more palatable. Knight states that the “political response trumped economic theory.” Well, theory is just a set of ideas. Ideas without action are just ideas. So one can’t neglect the role of leadership. The political response, a change in the rulers (Indonesia), capital controls (Malaysia), and austerity (South Korea), did not invalidate economic theory.

How, then, to return to the path of increased affluence? One proposal King offers is to increase labor mobility. How to accomplish this while anti-immigration sentiment continues to grow in several European countries and remains strong in the United States is another question.

The breakdown of some basic consensus about fair play and equality before the law is a major theme of the book. King writes compellingly on the loss of trust: “With heightened levels of trust, there is less need for bureaucracy: rules, regulations and legal enforcement can be reduced without wider costs.” In contrast, “without trust, economic growth will be in short supply. And with neither trust not growth, society is in danger of disintegrating.”

Who is to blame for this loss of trust? “Banks—deservedly in some cases—are no longer trusted. People within the financial system no longer trust each other.” The author speaks as a privileged witness to the events he writes about. He mentions his own employer, HSBC, as “involved in a particular distasteful money-laundering scandal concerning Mexican drug money, ending up with a deservedly heavy fine of $1.9 billion from the U.S. authorities.” Barclays and Northern Rock (which got billions in bailout money, denting the image of the former co-chairman, a famous advocate of laissez-faire economics) are also mentioned, as is Goldman Sachs, which he says helped Greece deceive its creditors.

The concern that King shows about this issue is notable if you consider the banking circles he moves in. His critique pales, of course, compared to the outrage that exists beyond those circles. Citizens are up in arms that executives or employees of these banks continue at the helm. While small drug offenders end up in jail, the powerful banking accomplices are only required to pay large fines—and these tend to be passed to shareholders who are content with the “big picture.” The fact that banks have become not only “too big to fail” but also “too big to jail” also contributes to the loss of trust. For most, the banking elite belong in the shady and questionable “wise guys” category.

The weakening of trust, according to King, is also caused by a certain type of income inequality—and this can lead to intergenerational or even class warfare. He concludes that:

what matters is not so much whether a society is unequal but, rather, why it is unequal. Did the wealthy enrich themselves unfairly? Were the poor exploited? Or, instead, did inequality arise through voluntary exchange, in which case there might be little need to worry.

I agree completely with the first part of the statement. Corruption, cronyism, and cumbersome regulations choke the growth of the small companies and businesses where the poor enter the market. This creates an inequality which should be of great concern. Its negative effects conspire against long-term affluence. Corruption and cronyism contribute to what I call an “unequal distribution of economic freedom.” As to whether “there might be little need to worry” if the inequality is the result of purely voluntary forces, I would say this: Given that inequality is basically the result of the ability to earn an income, and that this ability is determined mostly by education, there might be some need to worry.

Are today’s educational systems adequately opening up opportunities for the poor? King does not focus on elementary or high school education but has some criticisms, and valid ones, of higher education and especially the teaching of economics. He writes:

The dismal science has become a dismal failure. It must do better. Its obsession with precision-engineered mathematical models . . . has made its conclusions both unintelligible to the average policy-maker and hopelessly unable to confront the uncertainties that prevail in the real world.

It isn’t only the mathematical economists who get it wrong. The neglect of history affects economists and social scientists of all fields. The past seems to have no relevance for the modern positivist. King notes that universities neglect economic history,

far better to ensure that budding economists could master the mathematics of vector autoregressions and dynamic stochastic general equilibrium models than know anything about the Gold Standard, the Great Depression or the ideas of the great political economists.

We do need an educational overhaul, as he says, though he does not offer recommendations on how to achieve this. One can only hope that the impact of the new technologies and globalization on the academic world might lead to positive changes in the academy.

Likewise the author does not put in concrete terms the personal changes needed in attitude and behavior, which would seem to flow from his diagnosis of the demise of trust. What social or political movements would need to develop to bring about the needed change? Other post-crisis books address that issue. But by focusing on the many financial and monetary aspects of the current situation, Stephen D. King gives abundant reasons for the need to reassess and readjust our mental and economic models and expectations.